Friday, December 14, 2012

Fed’s Fisher Worries About ‘Hotel California’ Monetary Policy

This is a great characterization by Dallas Fed President Richard Fisher.

He said Friday on CNBC he opposed the Federal Open Market Committee‘s recent decision on targeting employment and he was extremely concerned that it would become increasingly difficult to exit the Fed’s accomodative monetary policy.

“We are at risk of what I call a ‘Hotel California’ monetary policy, referring to the Eagles’ song, where we can check out any time we want from this program, but we can never leave” due to the massive growth in the Fed's balance sheet, he said.

As I have pointed out many times, a large portion of money that the Fed has printed has been put, by banks, back at the Fed as excess reserves. At present, $1.4 trillion sits in excess reserves that banks, at any time, could draw on and loan out. They only earn 0.25% with the Fed. The big question is how does the Fed prevent this money from rapidly flowing out in the system?

Thus, the 'Hotel California' problem. The Fed can raise reserve requirements or interest rates on excess reserves to stop outflow, but this could result in a dramatic increase in market interest rates. Thus the Fed can check the money flow at anytime, but can they really leave the money printing scene, given what it would do market interest rates?

Couldn't the Fed just pay a higher rate on excess reserves? If commercial banks feel the risk is worth the extra rate earned in the markets, the Fed could simply offer a rate that's marginally higher. Of course, this would lead to ever increasing monetary-inflation, but it would keep excess reserves at the Fed and NOT leveraged in the market. Comments and critiques welcome...